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Ethical Commitment Index, Corporate Governance and Financial Performance
in Listed Company Indonesia.
Medina Amanda S.Mn, QWP.
Institut Teknologi Bandung
School of Business and Management, Institut Teknologi Bandung, Jl. Ganesha No. 10
Bandung, 40132.
Yunieta Anny NainggolanPh.D.
Institut Teknologi Bandung
School of Business and Management, Institut Teknologi Bandung, Jl. Ganesha No. 10
Bandung, 40132.
ABSTRACT
Recently, Corporate Governance (CG) and Business Ethics become a major
consideration in corporate strategies, especially in emerging market where the
application of both issues are not executed well (Peters, Miller, & Kusyk, 2011).
Indonesia as emerging market has experienced both issues seen from lowest ranking
in CG Quality ASEAN and dropped two ranked 90 th in Free Corruption Country
regarding ethics. By entering the globalization era with borderless business activities,
Indonesian companies face more milestones in theglobal marketplace. This era is in
line with the advancement to both issues since the application of these two will lead
companies to the financial performances dipped, revenue losses, bad reputation, and
even bankruptcy (Mascarenhas, 2015). Furthermore, in investment strategies, a
variety of investors would consider those factors in making a decision. In fact, the
prior studies regarding ethical commitment index have never been conducted in
Indonesia. This research examines the relationship of corporate governance, ethical
commitment index and company financial performance in listed company in
Indonesia. Ethical commitment index will be used to measure business ethics, while
corporate governance is going to be assessed from local, foreign, managerial
ownership, board size, independent managerial, and audit committee. In generating
the result, the execution of multi-linear regression is conducted. This research finds
that ethical commitment index has no relation toward financial performance. While
the increasing of manager ownership concentration and concentration of audit
committee will decrease a financial performance in Indonesia. Moreover, the higher
managerial ownership tends to have a less concern of ethics in a company. This
research suggests the company to pay more to their ownership structure and
effectiveness of audit committee besides support government intention to enhance
those issues. Besides, the managerial ownership and audit committee of a company
can be a consideration for aninvestorbefore making an investment decision.
Keywords: corporate governance, ethics, ethical commitment index, financial
performance.ownership concentration, board size, independent managerial, and
audit committee.
INTRODUCTION
Understanding factors that affect financial performance are one of the goals in
corporate management. Knowing those factors, the company expects to achieve good
financial performance and minimize the risks that will affect financial performance in
the future. For few decades, corporate governance and ethics become an issue that
noticed by the company. With good corporate governance and ethics application, it is
expected thecompany will gain trust both from investor and consumer.
Entering globalization era, theborderless area makes companies face more risks,
challenges, and competitions in global market place. This era also increases the
importance of corporate governance because it will help companies to minimize the
risk in liberalization and walk on the right path. Additionally, corporate governance
becomes more important due to the increase of corporate failure caused by bad
governance application. It can be seen from the collapse of Barings Empire, Daiwa
Bank debacle, and Maxwell Affair. One of the main reasons for their collapse is the
lack of corporate governance (Shahid, 2001). Bad corporate governance is also
related to bad ethics. For instance, one of the biggest companies’ bankruptcy in the
United States, Enron in 2001. They are proven to be doing collusion, corruption,
nepotism and also their manager was arrested (Smith, 2004). This shows that bad
ethics and corporate governance will lead companies to company performances
dipped.
Researchers have started to study the relationship of corporate governance and ethics
to corporate financial performance, especially in developed countries such as the US,
Spain, and South Korea. The result shows different findings, especially in emerging
market where the applications of corporate governance were not executed well
(Peters, Miller, & Kusyk, 2011). In Indonesia, as an emerging market has the lowest
score in Ranking Asian Market on CG Quality (Asian Corporate Governance
Association (ACGA), 2014). Besides corporate governance, Indonesia also has got a
problem related to ethics. It is proven by the fact that Indonesia declined 2 rankings,
from the 88th to the 90th free corruption country in ASEAN (Mazrieva, 2017).
To resolved the issues, many intentions have already been done by Indonesian
Government such as Indonesia’s Code of Good Corporate Governance in 2006 and
Law No. 40 of 2007 Article 74 which obligated the listed company to do Corporate
Social Responsibility (CSR). Those actions show a positive intention from the
government in improving the applications of both issues in Indonesian companies. It
also expects the improvement of corporate governance and business ethics in the
company in Indonesia.
In Indonesia, the studies related to ethics already done by different measurement such
as Islamic ethics questionnaire, but ethical commitment index and relate the data to
the financial performance in Indonesian company never been executed. Therefore,
based on the factors mentioned and knowing that this study has not been executed
before in Indonesia, this study needs to be executed.
In this study, business ethics measurement result is collected from ethical
commitment index by Nainggolan et, al (2017) in their working paper. Ethical
Commitment Index (ECI) method has also used by Choi & Jung (2008) and Pae and
Choi (2011) in South Korea. This study aims to analyze the relationship between
ethical commitment index, corporate governance toward corporate financial
performances. By knowing the relationship between those variables, it will help
investors and individuals, who have aconcern about corporate governance and
business ethics, make decisions in the portfolio investment.
LITERATURE REVIEW
Ethics is one of the branch studies in philosophy that has core value in arranging,
maintaining, and recommending the right and wrong action(Jenning, 2005). Ethics
that applies in a business context is called business ethics. According to Epstein
(1989), business ethics focuses on general principles and analytical approaches in an
ethical path based on aparticular field in business activity. It also examines theethical
problem that appears in abusiness environment (Solomon, 1991). The role of ethics is
essentialfor the business effectiveness of a company(Singhapakdi, 1991). If there is
no any implementation of business ethics, ethical and agency problems will easily
arise in an organization. Furthermore, the companies with high ethical values will
have a competitive advantage such as improved employee morale, better reputation,
more trusted investor relations, and lower cost of capital. All of the competitive
advantages will lead companies better financial performance in the long run.
In order to institutionalize the business ethics application in corporate, it requires a
guideline called code of ethics. According to Business Dictionary, code of ethics is a
set of guideline to help management within the corporation in conducting their action
which in line with the ethical standard. In other literature, Kaptein & Schwartz (2008)
explained that code of ethics consists of set principles that develop by the company to
be a guideline issue for at least manager, employee, company, toward stakeholders
and society in general. Although there is no warranty, the institutionalization of ethics
is important due to increased occurrence of unethical behaviour within
theorganization(Chua & Rahman, 2011).
One of the ways to improve and monitor ethics is from corporate governance.
According to Organization for Economic Cooperation and Development (OECD)
(2004), corporate governance is set of structures that relate to a relationship among a
company’s management, directors, its shareholders, and other stakeholders. All of the
stakeholders from corporate governance are expected to control all the activities by a
certain right that existing in legal framework on corporate (John & Senbet, 1998).
Corporate governance represents institutional arrangements, decision-making
mechanisms, and organizational design(Lu & Zhang, 2016). Based on previous
literature, application of corporate governance and their effects on companies
performances showing different findings. Gompers, et al (2003) find that’s firm with
highest corporate governance will have higher performance related to firm value,
profit, and sales growth. Contrarily, Maka&Kusnadi (2005) indicates inversely
relationship between corporate governance and firm value in countries.
In Indonesia, the government released the first Code of Good Corporate Governance
by The National Committee on Corporate Governance (NCCG) in 1999. Low
corporate governance rating and a multi-dimensional crisis in Indonesia is one of the
reasons that pushed thegovernment to improve the code. Continuously improving
from 2001, 2004, In 2006 National Committee of Governance released The Code of
Good Corporate Governance Indonesia as guideline code for companies to implement
Good Corporate Governance (GCG) in Indonesia.GCG has 5 principles values which
ensure the companies to achieve sustainability and consider the interest of
stakeholders. These values are transparency, accountability, responsibility,
independency, and fairness.
PREVIOUS STUDIES
Corporate governance becomes an interesting topic to discussed and examines by
many researchers. Past studies have found different findings regarding the issue. In
term of the relationship between corporate governance and financial performance, the
findings show a mixed result. Some of the studies find the positive relationship such
as Abdallah & Ismail ( 2006) which explain a positive relationship between corporate
governance and firm value. This research conducted in 2008-2012 to all firms listed
in GCC (The Gulf Country) countries. The same result also shows in Gompers, et al
(2003). Contrarily, the other studies found anegative relationship between corporate
governance toward financial performances (Maka&Kusnadi, 2005). Maka & Kusnadi
(2005) found that large board related to theless efficient use of assets and effect to
lower profitability. Furthermore, Morck et al. (1988) also findnegative relationship
between corporate governance specifically managerial ownership toward financial
performance. Whileinsignificant relationship between corporate governance and
financial performance also shows in literature Ghazali (2010). A negative relationship
is due to time conducted the research was too early. All those research shows mixed
finding regarding corporate governance and financial performance.
Furthermore, many researchers also already started to studies business ethics or
ethical commitment index toward corporate financial performance especially
inadevelopedcountries such as South Korea, Spain, and US. Most of the studies have
shown positive significanteffect of ethics toward corporate financial performance.
Mascarenhas (2015) stated that unethical behaviour in conducting business will lead
to revenue losses. These findings means ethical commitment index has positive
relationship toward financial performances. Supporting this, Verschoor (1998) also
finds apositive relationship between ethical commitment and company financial
performance. He finds that the companies that include their ethical behavior in annual
reports show favorable corporate financial performance compared to those that do
not. On the side notes, there are another finding regarding thepositive relationship of
ethical commitment of company toward financial performance in (Elayan et al.,
2014) and ( Rodriguez and Fernandez,2015).
However, in Pae and Choi (2011) finds an insignificant relationship between ethical
commitment index and corporate financial performances. According to Pae and Choi
(2011), this research is consistent with previous studies which stated relationship
between business ethics is not clear enough to short-term measurement financial
performances. The more robust relationship for business ethics and financial
performance is applied for long-term effect (Choi and Jung, 2008; Preston &
O'Bannon, 1997).
Despite many studies regarding corporate governance and ethical commitment index
toward corporate financial performance, the relationship between ethical commitment
index and corporate governance also becomes an interesting topic. At a glance,
ethical commitment index and corporate governance seem identical, but actually,both
of the issues represent thedifferent area. According to Pae and Choi (2011), corporate
governance represents governance mechanism, while business ethics represent ethical
decision making from corporate. Past studies found that corporate governance is
positively significant toward ethical commitment index (Pae and Choi, 2011;
Brickley, Smith Jr., &Jerold,2002).
DATA
The sample of this research use 30 companies from respondent of questionnaire
Ethical Commitment Index from Nainggolan et al. (2017). Those 30 companies, will
be used to analyze ethical commitment index, the corporate governance and financial
performance in Indonesia. Furthermore, data for corporate governance and control
variables are gathered from Indonesia Stock Exchange (IDX) over period 2012-2016.
For the corporate governance, data obtained from theannual report of analyzed listed
companies. This report will identify the variables needed for measuring corporate
governance listed companies. The variables used for corporate governance are local,
foreign and managerial ownership, board size, independent managerial, and audit
committee of a company.
METHODOLOGY
This study aims to analyze the relationship among ethical commitment index,
corporate governance and financial performance. To analyze those issues, this
research used multi linear regression analysis. The first equation model used to test
therelationship of ethical commitment index toward financial performance as follow: CFP=β0+β1 ECI+Control+e
where ECI is ethical commitment index, and CFP is corporate financial performances
measurement which are ROE, NPM, ROA, and Tobin’s Q. Ethical Commitment
Index is expected to have a positive relationship toward company financial
performance since most of the studies show a positive relationship between ethics
toward company financial performances.
This research used 4 control variables. The four variables are Beta(b), Total Asset
(ta), Change of Sales (cs), and Financial Leverage (flv). Beta expects to have a
positive relationship toward corporate financial performance since the higher the risk,
the more return that company will get. Beta used for control a systematic risk of a
company. Furthermore, total asset expected to have a negative relationship toward
corporate financial performance (Dang & Li, 2013). The better financial
performance, the more asset used by the company to increase their financial
performance. Change of sales expects to have a positive relationship toward
corporate financial performance since the higher sales growth will have higher value
in a capital market (Dechow et al., 2004). The company that rely on debt financing
tend to have a good business ethics, therefore it will increase the return to the
company (Pae and Choi, 2011). Hence, this research expects a positive relationship
toward company financial performance.
The second equation model used to test the relationship between both Ethical
Commitment Index and Corporate Governance toward financial performance. The
equation as follows:
CFP=β 0+β 1 ECI+β 2CorporateGovernance+Control+e
where :
β 0 = Constant
β 1−β 7 = Correlation of Coefficient
e = Residual error of regression model
The dependent of this research is acorporate financial performance which divided
into 4 model which is ROA, NPM, ROE, and Tobin’s Q. The independent for this
research are ethical commitment index and corporate governance which will be
assessed from local, foreign, and managerial ownership, Independent Managerial,
Audit Committee, and Board size. Ownership of local shareholders is measured
aportion of share that own by anindividual, corporate, and also government in
Indonesia to a total number of shares.When a company have more dispersed
ownership, it will face higher agency cost and will decrease a financial performance
of a company (Ng'ang'a et al., 2016). Hence, this research expects a negative
relationship toward financial performance. Furthermore, ownership of foreign
shareholders is calculated from aportion of foreign shareholders in a company. This
research expects a positive relationship between foreign shareholders towards
corporate financial performances because foreign ownership used as aproactive
legitimate action to ensure continued inflows(Haniffa & Cooke, 2005) which will
increase a financial performance of a company.
Ownership of managerial shareholders is a portion of share ownership by board
directors and commissioners inside the company to a total number of shares
(Wahihdahwati, 2002 cited from Irawan& Nainggolan, 2016). Agency problem arises
when a manager inside the corporation owns a little stock of a company. They did not
have asense of ownership and lead to opportunistic behavior(Jensen & Meckling,
1976). While, if the manager owns more stock of a company it will reduce agency
cost and improve manager effectiveness in conducting business. Hence, this research
expects a positive relationship between managerial shareholders toward financial
performances.
Board size measures the total number of directors and commissioners in the
company. Indonesia applies two-tier board structure where the board of
commissioners are separated from the board of directors (Hermawan, 2011).Board
size expects to have negative relationship toward corporate financial performances
since the higher board size will lead thecompany to ineffective communication,
control and decision making and will lead to decreasing performances(Jensen, 1993).
Moreover, independent managerialis the proportion of independent directors plus
independent commissioners to total managerial (directors and commissioners).
Independent managerial will help board director to control the business activities and
increase theeffectiveness of theboard of directors (Said et al., 2009). The more
effective board of directors will lead to better financial performance. Hence, a
positive relationship between independent directors toward corporate financial
performances is expected.
Audit committee function as monitoring committee to ensure internal control system,
internal and external audit, good corporate governance is going well. They also have
to monitor and review company’s compliance based on Indonesia law and existed
regulation. The audit committee is expected to have a positive relationship toward
financial performance since it can reduce agency cost and increase internal control of
a company. So, it will increase the performance of a company. Moreover, this
research equation used 4 control variables. The four variables are Beta, Total Asset,
Change of Sales, and Financial Leverage.
The third equation model aims to analyze the relationship between corporate
governance toward ethical commitment index. The equation model as follows: ECI=β 0+β 1Corporate Governance+Controls+e
The dependent variable for this equation is Ethical Commitment Index (ECI).
Furthermore, independent variables use corporate governance measurement which
are local, foreign and managerial ownership, board size, independent managerial, and
audit committee.
Corporate governance expects to have a positive relationship toward ethical
commitment index since the more comprehensive corporate governance tend to have
a strong business ethics (Pae and Choi, 2011). While for control variables are use
beta (5-year rolling beta from the CAPM), Total asset, change of sales and financial
leverage.
RESULT AND ANALYSISTable 1 Descriptive Statistics for 5-years Average
Mean SD Minimum Maximum
Dependent Variable
Return on Equity (ROE) 0.135 0.511 -1.440 2.266
Net Profit Margin (NPM) -0.153 1.197 -6.470 0.253
Return on Asset (ROA) 0.282 0.452 -0.040 1.826
Tobin's Q 1.20 2.082 0.044 10.597
Independent Variables
ECI 9.000 2.150 4.000 11.000
Local Ownership 0.749 0.287 0.065 1.000
Foreign Ownership 0.231 0.276 0.000 0.928
Managerial Ownership 0.020 0.077 0.000 0.414
Board Size 8.433 3.380 3.000 18.000
Independent Managerial 0.283 0.165 0.000 0.750
Audit Committee 0.133 0.115 0.000 0.400
Control Variables
Total Asset 928847121699 45 117960455 226161395566678
Financial Leverage 2.236 1.665 -1.164 8.441
Change of Sales 0.125 0.435 -0.408 2.233
Beta 0.575 1.611 -7.322 2.516
This table presents the mean, standard deviation (SD), minimum value, and themaximum value of all regression
variables. It is calculated from 30 companies in Indonesia Listed Companies for 5-year averages.
Table 1 shows descriptive statistics for 5-year average. From the descriptive statistic
above, the average net profit margin of this research is -15.2%. It is abad indicator for
their financial performance. However, theinvestordoes not pay attention to it since the
market value is still higher than its true asset value. It is shown by the average
Tobin’s Q of these company is higher than 1. The justification of this anomaly may
come from its good ROA and ROE of these companies which are 28.1% and 13.5%
respectively. Furthermore, descriptive statistic data shows that the application of
ethics in Indonesia is quite good, it is shown in the mean average ethical commitment
index is 9 out of 11. Indonesia is dominated by local ownership which has around
average 75% of share, foreign own 23% of the share, while manager just owns 2% of
share in Indonesia company.
For the last five years, acompany in Indonesia already fulfilled the regulation which
obligated the company to have at least 4 board of directors and commissioners. From
the data, we can see mostly the Indonesian company exceed the government order by
has more board managerial. Some companies in Indonesia did not use independent
managerial, while they already applied and fulfilled minimum requirement for audit
committee which is at least 2 people
Table 2 Descriptive Statistics for End Year of 2016
Mean SD Minimum Maximum
Dependent Variable
Return on Equity (ROE) 0.208 0.630 -0.419 3.399
Net Profit Margin (NPM) -0.321 1.963 -10.659 0.330
Return on Asset (ROA) 0.400 0.685 -0.115 2.881
Tobin's Q 1.302 2.102 0.041 10.480
Independent Variables
ECI 9.000 2.150 4.000 11.000
Local Ownership 0.743 0.274 0.084 1.000
Foreign Ownership 0.235 0.260 0.000 0.916
Managerial Ownership 0.022 0.101 0.000 0.550
Board Size 8.200 3.438 3.000 18.000
Independent Managerial 0.298 0.185 0.000 0.750
Audit Committee 0.779 0.409 0.333 1.667
Control Variables
Total Asset13538858755
3 40 119640264
26190422515096
5
Financial Leverage 2.105 1.275 -0.618 6.435
Change of Sales -0.067 0.249 -0.862 0.196
Beta 0.575 1.611 -7.322 2.516
The table presents the mean, standard deviation (SD), minimum value, and maximum value of all
regression variables. It is calculated from 30 companies in Indonesia Listed Companies for end year of
2016
From the descriptive statistics data for end year of 2016, the average net profit margin
shows -32,12%. The decreasing performance is higher than the 5-years average
descriptive statistic data. Although the NPM show anegative result, it not affects the
ROA and ROE, because the return is increasing compare to 5-years average data.
Hence, this increasing of both indicators make the market value higher than its true
asset value and increase from the 5-years average.
Ethical commitment index assumed not change for the past 5 years. Hence, in the
endyear of 2016, the descriptive statistics show that some companies in Indonesia
have highest commitment value toward ethics. It can be seen from the maximum
value of the variable ECI (11) which is the highest score of ECI measurement.
Furthermore, application of ethics in Indonesia is quite various, seen by the range of
ECI is quite high with 7 point differences.
Ownership of share in Indonesian company is still dominated by local shareholders.
Foreign ownership owns about 20 percent of share in Indonesia, while managerial
ownership just owns 2.2% in end year of 2016. The is no significant differences of
ownership for the last five years and end of year 2016.
Correlation between independent variables is important because high correlation will
lead to bias conclusion. The high correlation between independent occur when the
correlation value is above 0.5. For average 5 years, table 4.5 shows that most of
variables did not have high correlation between each other, so they can use in one
model regression. However, there is one independent variables that has high
correlation which is local ownership(lo) and foreign ownership(fo). In order to solve
the high correlation problem, this research need to separate local ownership and
foreign ownership into different regression model.
For Independent variables in the end of year 2016, the correlation matrix on table 6
shows ahigh correlation between some variables. The variables are between local
ownership(lo) and foreign ownership(fo), independent managerial(im) and audit
committee (ac), board size and audit committee(ac), and between financial leverage
(flv) – change of sales (cs). Those variables need to be separated into various
regression model to overcome the correlation problem.
Regression ResultTable 5 Regression Result for 5-years Average The Relationship between ethical commitment index, corporate
governance and financial performances
Model (1)-(4) aims to test the relationship between ethical commitment index toward
corporate financial performance for average 5 years. The result is expected to show a
positive relationship between ethical commitment index toward corporate financial
performances. From Model (1)-(4), all the regression result shows that ethical
commitment index is statistically insignificant toward company financial
performance. Hence, there is no evidence to support thehypothesis for therelationship
between ethical commitment index and company financial performances. It means
that there is no robust effect between ethical commitment index toward financial
performances. The insignificant result due to different political and environmental
both for investor and market in Indonesia. An investor in Indonesia tends to see the
corporate governance of a company not the ethics of a company. One of the reason is
anethical commitment of a company is hard to measure and time-consuming, whereas
investor should decide stock on their portfolio in limited time.
However, the finding is consistent with theprevious result which stated that ethical
commitment index shows insignificant differences to short-term measurement
financial ratio such as ROA, NPM, ROE (Pae and Choi, 2011 and Preston &
O'Bannon, 1997). It can be concluded that research is same with Indonesia cases,
which has more ethics problem compare to develop countries. Moreover, the result
might also because of the time in conducting the research is not too long so it cannot
interpret the long-term effect of this issue.
Model (5) to Model (12) examine therelationship between both corporate governance
and ethical commitment index toward financial performance for average 5 years.
Model 5-8 will assess corporate governance from local, board size, independent
managerial, and audit committee. While model 9-12 will assess corporate governance
from foreign and managerial ownership. From the regression result, it shows different
findings with the hypothesis which expect apositive relationship between ethical
commitment index and corporate governance toward financial performances.
Evidently, the result only shows a negative significant relationship between corporate
governance through managerial ownership toward corporate financial performances.
While ECI, local ownership, foreign ownership, board size, independent managerial
and theaudit committee has no evidence to related toward corporate financial
performances. The significant and negative relationship between managerial
ownership to corporate financial performance is documented at model (11) in table 5
for 5-years average (-0.75). Interestingly, the result in Indonesia shows a conflicting
with the agency theory where managerial ownership will increase the manager
performance and increase financial performance.
The result also demonstrates that financial performances tend to decrease at a higher
level of managerial ownership. It is consistent with Morck et al. (1988) and Bebchuk
& Fried, (2003) where managerial ownership has negative related to financial
performance. Furthermore, Bebchuk et al., (2010) also find evidence that higher CEO
salary compares to other board directors will effect lower corporate value. The result
from this research might be occurring because of the higher managerial ownership
will lead manager to have agency conflict, when the dominant manager has
atendency to do more exploitation in the company. This action will lead to decreasing
performance of a company.
For control variables, in table 9 model (4) and model (12) total asset shows positive
and significantly related to Tobin’s Q. Table 6 Regression Result The Relationship between ethical commitment index, corporate governance and financial
performancesfor End Year of 2016.
For end year of 2016, the relationship between ethical commitment index and
financial performance result is consistent with the 5-years average. It can be seen
from themodel (1)-(4) which show there is no evidence between ethical commitment
index and financial performance. The author finds no evidence to support the
research hypothesis which expects a positive relationship between ethical
commitment index toward financial performances. Furthermore, it also means that
ethical commitment index not strong tendency related to financial performance for
both long-term and short-term periods
However, the finding is consistent with theprevious result which stated that ethical
commitment index shows insignificant differences to short-term measurement
financial ratio such as ROA, NPM, ROE (Pae and Choi, 2011 and Preston &
O'Bannon, 1997). It can be concluded those research is same with Indonesia cases,
which has more ethics problem compare to develop countries
Model (5) to Model (12) on Table 6 examine therelationship between both corporate
governance and ethical commitment index toward financial performance for end year
of 2016, respectively. Model 5-8 will assess corporate governance from local, board
size, and independent managerial. While, model 9-12 will assess corporate
governance from foreign, managerial ownership, and audit committee. The corporate
governance regression model is separated due to existing high correlation among
independent variables. The regression result shows a consistent result with the result
for 5-years average. This documented a negative significant relationship between
corporate governance through managerial ownership (-0.85). It means that both for
short-term and long-term shows tendency that the higher level managerial ownership
will decrease financial performances of a company and conflict with agency theory
where the higher managerial ownership will decrease agency problem. This is an
interesting topic to deeply focused more on the further research. This might be
occurring because of the higher managerial ownership will lead to extraction by
dominant ownership at expense of minor shareholder. This event will lead to agency
problem between minor shareholder toward company and in the end, will lead to
decreasing performance of a company.
Furthermore, for end year of 2016, the regression result also shows a negative
significant relationship between audit committee and ROA in model (11) in Table 6
Audit committee has p-value 0.031 and coefficient -0.735. This finding is not
occurred in model (11) for average 5 years. This might due to the variables has more
tendency to short-term effect than long-term effect. Based on the result, the
hypothesis is rejected. It might be due to higher audit committee make the company
cannot do fraud or the regulation is stricter. So, the profit cannot be higher and have
tendency in decreasing profit than the company with less audit committee.
For control variables, there is insignificant result between total asset toward Tobin’s
Q in model (4) and model (12) in table 6 for end year of 2016 compare to 5-years
average regression result. Furthermore, the regression model (2), (3), and (6) shows
positive and significant relationship between change of sales to corporate financial
performance. While, beta shows negative and significant relationship toward return
on equity in model (9).Table 7 Regression Result The Relationship between Ethical Commitment Index (ECI) and Corporate Governance for
5-years Average
Model (1) (2)ECI ECI
Constant 5.356 6.0281(0.064) (0.021)
Independent VariablesECI
Local ownership 0.489(0.746)
Foreign ownership 0.6618(0.717)
Managerial ownership -1.3264(0.57)
Board Size 0.2221(0.325)
Independent Managerial 0.5902(0.88)
Audit Committee -2.1068(0.618)
Control VariablesTotal Asset 0.0292 0.0849
(0.781) (0.316)Financial Leverage 0.4051 0.2621
(0.091)* (0.187)Change of Sales -0.5297 -0.1578
(0.427) (0.87)Beta -0.1999 -0.1176
(0.272) (0.391)R-squared 0.1814 0.0629Note: This table shows the coefficient and p-value. in the bracket () is p-value. *p<0.1;**p<0.05; ***p<0.01
ROE: Return on Equity; NPM: Net Profit Margin; ROA: Return on Asset; Tobin’s Q:Market Capitalization
Total asset;
ECI: Ethical Commitment Index; Table represent regression result for average 5 years
Table 7 examines relationship between ethical commitment index and corporate
governance for 5- years average in listed company Indonesia. Model (1) assessed
corporate governance from local ownership, board size, independent managerial and
audit committee. While model (2) assessed corporate governance from foreign and
managerial ownership.
Regression result show there is no evidence that corporate governance is significant
toward Ethical Commitment Index for 5-years average. This result is different with
ahypothesis which expects a positive relationship between corporate governance
toward ethical commitment index. It might be because corporate governance has
aninsignificant effect or tendency to explain the ethical commitment index in the
long-run. Furthermore, it can also occur because the ethical commitment index used
for this study is not calculated consecutively every year.For control variables,
financial leverage shows positive significant relationship toward ethical commitment
index.
Table 8 Regression Result The Relationship between Ethical Commitment Index (ECI) and Corporate Governance
Model (1)* (2)*
ECI ECI
Constant 6.2487 6.0252
(0.07) (0.008)
Independent Variables
ECI
Local ownership -0.2293
(0.901)
Foreign ownership 1.7831
(0.23)
Managerial ownership -2.701
(0.089)*
Board Size 0.1634
(0.336)
Independent Managerial 2.7042
(0.371)
Audit Committee -1.571
(0.245)
Control Variables
Total Asset 0.0376 0.1078
(0.647) (0.071)*
Financial Leverage 0.464
(0.063)*
Change of Sales 2.0289
(0.463)
Beta -0.2457 -0.227
(0.117) (0.085)*
R-squared 0.1613 0.2073
Note : This table shows the coefficient and p-value, in the bracket () is p-value. *p<0.1;**p<0.05;
***p<0.01
ROE: Return on Equity; NPM: Net Profit Margin; ROA: Return on Asset ; Tobin’s Q:
Market CapitalizationTotal asset ; ECI: Ethical Commitment Index; Table represent regression result for end year
of 2016
Table 8 examines corporate governance toward ethical commitment index for end
year 2016. Model (1) assessed corporate governance from local ownership, board
size, and independent managerial and model (2) from foreign ownership, managerial
ownership and audit committee. Regression shows there is negative and significant
relationship between managerial ownership toward ethical commitment index. The
result is different with ahypothesis which expects a positive relationship between
managerial ownership toward ECI. Managerial ownership has p-value 0.089 and
coefficient -2.701. It is different with the hypothesis which expectspositive
relationship between corporate governance to ECI. This might occur due to high
managerial ownership will lead to high agency problem because manager feels like
they own the company. High possibility of agency problem will lead to unethical
behavior of thecompany. For short-time managerial ownership will have significant
effect toward ECI, however, for long-time, the effect of managerial ownership will
fade. It can be seen from the regression result in 4.11 which documented there is no
significant result between corporate governance toward ethical commitment index for
average 5 years. Furthermore, it also might happen because the manager not paying
attention to ethics, the ethics more like symbol not an application. Hence, the higher
managerial ownership will lead to less concern toward ethics. For control variables,
total asset and financial leverage show positive and significant relationship toward
ethical commitment index.
CONCLUSION AND RECOMMENDATION
Globalization makes competition fiercer and need high speed of change. This era also
confronts with trust issue where right and wrong fall in between. In a competitive
market, thebehavior of a company is monitored by themarket and will affect directly
to financial performance as well as stock price. Started from decreasing financial
performance even bankruptcy of many companies in the world due to lack of ethics
and corporate governance. Both issuesbecomes important to be considered.
Furthermore, theinvestor also tends to see both indicators before decided their
investment. Many researchers, especially in developed market, already study and
confirm mixed findings of ethics and corporate governance. Although Indonesia has
alow ranking of corporate governance index and more problem regarding ethics,
thegovernment already shows some intentions to enhance the issue in business
activities in Indonesia. Furthermore, there are none of thestudies in Indonesia that
examines about ethical commitment index toward financial performance. This
research aims to give the perspective of ethical commitment application in Indonesian
company as well to fill the gap and contributes to the literature on corporate
governance, ethics and corporate financial performance.
This study aims to know the relationship between ethical commitment index and
corporate governance toward corporate financial performances in Indonesia listed
company. The sample data for this research obtained from anethical commitment
index respondent questionnaire of Nainggolan et al. (2017) which are 30 companies
from liquid listed company in Indonesia Stock Exchange. Multi-linear regression is
conducted between independent and dependent variables. Dependent variables of
this research are corporate financial performance and ethical commitment index.
Corporate financial performance measured by ROA, ROE, NPM, and Tobin’s Q.
While independent variables are ethical commitment index, local ownership, foreign
ownership, managerial ownership, board size, independent managerial, and audit
committee.
This result of this research are as follow:
1. There is no evidence that Ethical Commitment Index has relationship toward
financial performances. The result shows ethical commitment index has
insignificant result toward corporate financial performance. This might happen
because ethical commitment index will have long term effect to increase the
financial performance. Besides, this supports a statement that ethical commitment
index has no clear relation toward short-term financial performances and has
themore robust effect on long-term performances.
2. Between ethical commitment index and corporate governance, only corporate
governance through managerial ownership that has a negative significant
relationship toward corporate financial performances. Interestingly, it conflicting
with the agency theories and attractive to deeply discussed for further research.
The result for average 5 years is consistent with the result for the end year of
2016 which means the variables have atendency both for short-time and long-
term effect. This might be occurring because of the higher managerial ownership
will lead to sources extraction by dominant ownership at expense of minor
shareholder. This event will lead to agency problem between minor shareholder
toward thecompany and in the end, will lead to decreasing performance of a
company. This finding indicates that in Indonesia, high managerial ownership in
company Indonesia will have lower efficiency for business operation and
decrease financial performances.
3. Corporate Governance through audit committee has also negative significant
relationship toward corporate financial performances for end year of 2016. It
might be due to higher audit committee make the company cannot do fraud or the
regulation is stricter. So, the profit cannot be higher and have atendency in
decreasing profit than the company with less audit committee.
4. This research suggests the company to pay more to their ownership structure and
effectiveness of audit committee besides support government intentions to
enhance corporate governance and ethics. So, the existing of managerial
ownership and audit committee can increase financial performance rather than
degrade performances.
5. This research also highlights the relationship between ethics and corporate
governance. The empirical result documented a negative and significant
relationship between managerial ownership toward ethical commitment index.
This might be due to higher managerial ownership will lead to higher agency
problem since the dominant manager will exploit more at expense of minor
shareholder and lead. Higher agency problem will lead to dipped commitment
toward ethics such as corruption, political motives, and expropriate for
theindividual benefit (Wright et al., 2002). High possibility of agency problem
will lead to unethical behavior of thecompany. For short-time managerial
ownership will have significant effect toward ECI, however, for long-time, the
effect of managerial ownership will fade. It is also might happen because
manager tends to see ethical commitment as a symbol not an application. This
result suggests the company to ensure manager objective who own share is in line
with company objective to prevent agency problem and unethical behavior.
Furthermore, it is better for themanager to change theperspective of ethical
commitment as asymbol into theapplication of ethics, so higher managerial will
lead to better company commitment toward ethics.
The scope of this research has limited sample and time conducted. Time to do this
research is only one year and ethical commitment index respondent just 30 out of 305
listed company in Indonesia. Least number of respondent ethical commitment index
questionnaire can also be an indication that companies in Indonesia do not really pay
attention to theethical commitment of a company. This research use data from ethical
commitment index respond result from Nainggolan et al. (2017) working paper,
company annual report data, and financial report from Indonesia Stock exchange
(IDX). Further research can extend the number of thesample through more sample
from respondent ethical commitment index questionnaire and the time conducted the
research. Furthermore, to find amore comprehensive representation of corporate
financial performance toward ethical commitment index and corporate governance,
further research can use ECI changes over ayear or add another measurement into
ECI. It can also add another dependent and independent variable in order to get more
exact and robust result regarding ethics, corporate governance, and financial
performance.
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